The Economist was not too sure about one particular stockmarket launch back in 1868. This was a new company raising a little over £500,000 for a new concept.
The idea is very good, opined the magazine, but the shape is very peculiar, and the exact idea upon which it starts has never been used before.
Victorian values today
Foreign & Colonial (F&C) – for it was this investment trust the magazine was describing – intended to pool British investors’ money to invest in risky assets, not British government bonds then yielding 3.3 per cent, but a selection of empire and British-influenced foreign country bonds offering a combined yield of more than 6 per cent.
Early investors had no cause to complain: over the next 150 years, the investment trust produced a compound annual return of 8.1 per cent.
Of course, the managers had to be aware of changing conditions. These included rising economic competition from the US and Germany, two savage and destructive world wars, the appearance of inflation and its effect on bond yields (and values), and the end of the empire and British power.
From the 1920s onwards, F&C began to invest in equities. The investment company has now increased its dividend every year for the past 47 years, and has more recently begun to invest in “private equity” opportunities. It charges a modest 0.37 per cent annual fee.
But this is not the only ‘dividend hero’, as the Association of Investment Companies (AIC) calls those portfolios that have raised payouts for 20 consecutive years or more, and several have done even better than F&C.
Adjusting to the future
Not surprisingly, investment trusts were a great success until after the second world war. At that point, unit trusts were reintroduced as a means of pooling assets within the British economy, and these were much more profitable for investment managers than their predecessors.
And the public forgot the advantages of investment companies, until the rocketing costs of investment management and poor stockmarket returns began to tarnish the heavily promoted advantages of unit trusts.
Treasury restrictions meant that investment trusts and insurance companies were the only types of asset managers allowed to invest internationally until sterling convertibility in 1989.
But they languished, often trading at considerable discounts to their asset value, and all too soon were gobbled up by manufacturing companies keen to buy international assets on the cheap.
As the industry celebrates 150 years since the launch of F&C, new research has revealed the extent to which the survivors have flourished. The average investment company has outperformed the FTSE All-Share and MSCI World indices, and the average open-ended fund, over 30 years to the end of March 2018. The average investment company has returned 1,955 per cent, equivalent to a £100 lump sum becoming an impressive £2,055.
By way of comparison, the FTSE All-Share gained 1,196 per cent (or £1,296), the MSCI World produced 944 per cent (or £1,044), and the average open-ended strategy returned just 919 per cent or (£1,019) ,
The lure of technology
But facts such as these seem to have no effect on the investing public. When unit trusts displayed their failings in the early years of the current century, investors turned to ETFs.
As these also disappointed, ‘smart beta’ took over, and now one of the largest investment houses of all is putting its faith in artificial intelligence.
As the FT recently reported: “Last year, Larry Fink finally threw his lot in with the machines. On 28 March, BlackRock unveiled a secret project code-named ‘Monarch’, a radical restructuring of its equities unit that is still reverberating across the industry.
“The chief executive took an axe to BlackRock’s underperforming stock-picking business, sacking seven fund managers and shifting billions of dollars they used to manage to a little-known arm of the asset manager’s sprawling $6trn [£4.5bn] empire based in San Francisco, called Systematic Active Equities [SAE].
“When BlackRock, in 2009, swooped for Barclays Global Investors, the crown jewel was the iShares ETF business, the biggest player in a growing industry that recently smashed past $5trn of assets under management. But some at BlackRock now reckon that the simultaneous acquisition of SAE – a $100bn computer-powered ‘quantitative’ investment unit – could turn out to be an even bigger deal than the imperious iShares business.”
Faster is not always better
SAE is much older than BlackRock. It was originally an index-tracking firm called Scientific Active Equities, set up by Wells Fargo Bank in 1971 in an attempt to throw off the ‘Hicksville’ image of west coast banks at that time.
Fifteen years later it pioneered smart beta tactics, based on research which indicated that investors could beat the market by ‘tilting’ towards certain stock characteristics such as cheapness.
As the FT also reports: “One of the biggest trends in the money management industry is the explosion of interest in quantitative investing, using high-powered computers and artificial intelligence to scour markets and gargantuan data sets for patterns that can be exploited by trading algorithms.”
But this means that costs are high, and the benefits are quickly lost. Although SAE was the first into this field, it has certainly not proved that commercially successful. That is because, in the end, technology is being used to trade faster and more cleverly than the opposition, rather than to concentrate on what investment is about – buying stable, safe and growing income streams.
Guessing the future
Data sets are just that – an account of the past but with no appreciation of the future. However good and accurate, and however much we would prefer otherwise, the past cannot and does not predict the future. That remains unknown, and needs human imagination – and guesswork – to identify possibilities, though never probabilities.
The Victorians understood that the average investor wanted a return on their capital, and one as high as possible consistent with the safety of that capital. The structure pioneered by F&C has survived the test of time.
Incorporation as a company means an investment trust is able to write off its costs before tax, and to hold back income in the good years to help with the bad years (which always come eventually). But it also creates the necessary hierarchy to ensure performance – a board responsible to shareholders for overall strategy, and an investment manager responsible to the board for the tactical implementation of that strategy.
Or as the AIC sums it up: “The closed-ended structure, ability to gear, income benefits and independent boards are unique features that deliver strong, long-term performances for investment company shareholders. Investment companies are the ideal vehicles for active managers, giving them the tools they need to deliver benchmark-beating returns.”
